What is a business model?
There are many definitions of business models. They depict “the content, structure and governance of transactions designed so as to create value through the exploitation of business opportunities” (Amit and Zott, 2010) or represent “the logic of the organisation, the way it operates and how it creates and captures value for its stakeholders” (Baden-Fuller, et al, 2008). Business models are also stories that explain how organisations work, including how they make money and how they deliver value to customers at an appropriate cost (Magretta, 2002).
They are “a set of key decisions that collectively determine how a business earns its revenue, incurs its costs and manages its risks” (Girotra and Netessine, 2015) and embody “nothing less than the organisational and financial ‘architecture’ of a business”(Teece, 2010). Value creation is a common theme in the definitions of business models. The FRC encapsulated this by defining business models as “how the entity generates or preserves value over the longer term”. This is not surprising because every organisation exists to meet the needs of an identifiable group.
Value is experienced by that group when its needs are met. In that sense the main purpose or intended outcome of the activities of organisations is to provide value to their key stakeholders. That is why “value is at the heart of business models”. According to KPMG any description of the business model must include how the organisation is structured, the markets in which it operates, how it engages with those markets, its main products and services, its main categories of customers, andits main distribution methods. Thus the business model not only looks at how organisations create value but also includes how they deliver value (Magretta, 2002), capture value (Baden-Fuller et al, 2008) and make decisions that underpin value creation (Girotra and Netessine, 2015).
This gives us four parts of the business model: firms define value, purpose and strategy (i.e. make decisions about value), create it, deliver it and capture residual value for themselves and others. To define value, firms look at who they create value for, for what purpose and what counts as value for them. To create value, the focus is on how resources are sourced and turned into outputs that customers and others desire. This means defining a strategy. To deliver value means finding ways to get value to those they were created for. To capture value is to ensure that there is adequate residual value to share between the firms, their shareholders and others.
Each part of the business model is aimed at a range of stakeholders. All stakeholders are in view when organisations define value, although the customer is often prioritised. Those who provide resources and help turn them into outputs (e.g. suppliers and employees) are key when creating value. They also receive value from the organisation at the same time. Customers are the ones to whom value is delivered. The organisation captures residual value to share among the providers of financial capital, government, senior executives and for reinvestment. The parts of the business model are linked and aligned to each other.
In view of the foregoing, we initially concluded that a business model shows how a firm defines, creates, delivers and captures value for, with and to its key stakeholders in a consistent and coherent manner. However, following our global consultation in the summer of 2017 we have revised this definition on the basis that it is too static. We have therefore revised this as ‘a business model shows how a firm continually defines, creates, delivers and captures value for, with and to its key stakeholders as necessary over time.’ This definition can be illustrated with the business models of some FTSE-100 organisations published in their most recent strategic reports. (For example, Tesco’s business model has four parts that correspond to the four parts of the business model above.)
1. Customers: “Tesco exists to serve customers and our business model has customers as our number one priority. Our scale and reach mean we have the expertise to really understand our customers; allowing us to focus on the delivery of an offer with real value in all areas of price, quality, range and service. This focus means that we will champion our customers at every level and earn their loyalty.”(Define value)
2. Product: “The product we create for customers is developed by our product team. They work with our suppliers to source the best possible range of quality products that meet and anticipate our customers’ needs. Our relationships with suppliers are crucial to meeting our customer offer.”(Create value)
3. Channels: “To bring the best products to customers easily, we work through a range of channels … As part of improving our offer we will invest in making our channels even more efficient and convenient for our customers.” (Deliver value)
4. Reinvest: “Our clear priority is to improve Tesco for customers. As we do this, we have committed to reinvest any savings or outperformance into further improvements in our shopping trip.” (Capture value)
Similarly Unilever’s business model “begins with consumer insight that informs brand innovation, often with partners in our supply chain, to create products we take to market, supported by marketing and advertising across a range of distribution channels”. The objective is to achieve profitable and responsible growth over time and amid changing circumstances.